Pakistan: The Realities of Economic Reform

Following my most recent visit to Pakistan I noticed there seem to be many different and contradictory views about the government’s reform agenda supported by the IMF program. This piece addresses some of the key concerns on people’s minds.

1. The IMF dictated the content of the program.

The government mostly produced the policies supported in this program, which respond to key challenges facing Pakistan today.

The economic section of the PML-N party manifesto shows that most of the policies agreed with the IMF were actually those proposed by Prime Minister Sharif and his team before the elections, such as: fiscal consolidation, tax reform, measures to tackle the energy crisis, restructuring and privatizations of public sector enterprises, trade policy reforms, and steps to boost the investment climate.

2. The program doesn’t address some important problems.

The program can’t do everything, but it tackles Pakistan’s biggest economic issues as quickly as possible.

Many have questioned particular parts of the program. Some feel the program should do more to improve tax collections, or to cut corruption, or to reform the civil service, or to boost provincial tax revenues. These are certainly important issues but given time and capacity constraints we can’t focus on everything immediately.

The government and the IMF agreed the most important issues were: (1) the very large fiscal deficit, which could no longer be financed; (2) the critically low level of international reserves; and (3) the need for structural reforms—particularly in the energy sector—to get the economy out of the low-growth trap it has been mired in for years. The program aggressively tackles all three—the deficit will come down from 8 percent of GDP to around 3½ percent of GDP over 3 years, international reserves will be rebuilt to sustainable levels, and structural bottlenecks will be significantly eased.

Once the government addresses these core issues they can tackle other important challenges, but without stabilization first, the economy will be too unstable to support the other efforts.

3. The program may address the right issues, but in the wrong order.

With the economy in serious trouble, Pakistan didn’t have the luxury of postponing key stabilization measures.

Some have argued the program errs in focusing first on economic stabilization and then on growth. Others wanted to focus on improved tax collections before increases in tax rates. Likewise, some feel that energy supply should have been increased first, with tariff increases later. Let’s take these in turn.

If Pakistan wanted to postpone its stabilization efforts to focus on growth stimulus, how would the government pay for the postponement? And how would it finance the stimulus? Unlike the United States, which can sustain very large deficits because the world is willing to buy U.S. government bonds, Pakistan doesn’t have this luxury. Moreover, even if you could finance it, how effective will temporary stimulus be if investors know the government has not yet addressed underlying imbalances?

On improving tax collections and energy supply improvements, these reforms take years to bear fruit. Tax administration reforms will take 2-3 years to generate significant improvements in revenues. Energy supply enhancements can take even longer. So while it was essential to start those at the beginning of the program, the government made the wise decision to include quick wins early on to address the vulnerabilities while the reforms with longer gestation periods are ramping up.

4. IMF policies will hurt the poor, who will pay the brunt of the adjustment.

The program will broaden the tax base, and cut subsidies for the rich, while maintaining low energy prices for the lowest consumers and increasing public spending on the poorest.

In this program, deficit reduction will come not from cutting education and health programs, but mostly from raising revenues. This involves bringing people into the tax net by eliminating loopholes and special privileges, and by improving tax administration and enforcement. In Pakistan, a country of 180 million people, only 1.2 million individuals and firms file income tax returns, of which about half are corporate filers. That must change so that more of the burden falls on those who can most afford to pay.

Energy subsidies mostly benefit a small proportion of the population. The wealthiest are those who consume the most energy, so an across-the-board subsidy helps them most. The rest of the population has to endure 8-10 hours a day of load shedding during the summer months without being able to afford the private generators of the rich. Under the program, the lowest consumption levels will continue to be subsidized, while prices will go up to fully cover costs for the wealthiest. Energy supply will be better and load-shedding will fall.

The program also includes higher social spending. The 2013/14 budget includes a significant rise in education spending. The program also entails a large increase in targeted transfers to the poorest, through the expansion of the Benazir Income Support Program (BISP), a national cash-transfer scheme. The government will expand the program with the help of donors, which currently reaches 4.9 million households, to reach 6.6 million families. The stipend has increased by about 20 percent, and it will be adjusted for inflation in the future.

5. The program will generate recession; hurt the economy and the business sector.

Growth will initially fall, but will be much higher over time.

In the short-run it is true that fiscal adjustment will reduce growth. But continued instability would hurt growth much more by pushing the economy into crisis. The government has geared its structural reforms to enhance growth in the medium- and long-term. These reforms include measures to ease the energy bottlenecks that strangle economic activity, and steps to promote trade, improve the business climate and the competitiveness of Pakistani industry. More efficiency and competition will help generate more investment and millions of new domestic jobs.

6. This program is doomed to fail as did previous programs.

While success is by no mean guaranteed, this is an historic chance to fix long-standing economic problems and put the country on a higher growth path.

The government’s program aims to overhaul some of the structural deficiencies that have plagued the country’s economic prospects, while pursuing, at the same time sound macroeconomic policies and protecting the most vulnerable from the effects of fiscal consolidation, through the expansion of social safety nets. Program design has been adjusted to take into consideration the lessons of past failures and the IMF is willing to be flexible to adapt to unexpected developments. Support from other institutions is being mobilized to help. Prospects for success are enhanced by a democratically elected government firmly committed to doing what it needs to do to fix these long-standing problems and achieve its objective of making life better for 180 million Pakistanis.